Tax Consequences of Borrowing From an IRA

by Jamie Wilson

An individual retirement account (IRA) is often among the largest liquid assets many people possess. When times are tight, you may be tempted to tap that large source of funds, promising to pay it back later or build it up faster before your retirement. However, borrowing from your IRA before you hit retirement age causes you to incur additional taxes and penalties if you are not careful about when and for what purposes you withdraw funds.

Early Distribution Rules

If you withdraw funds from your IRA before the age of 59 1/2 for any reason other than a few exceptions, you will have to pay the full taxes on any as-yet untaxed portion of your account. For a standard IRA, this is all the cash in your account. For a Roth IRA, this applies only to earnings in excess of your already taxed contributions. In addition, you will have to pay a 10 percent additional penalty on all withdrawn funds to the IRS.

Exceptions to Early Distribution

If you are permanently disabled and unable to work, you can withdraw cash from an IRA with no additional penalty, although untaxed funds will be subject to regular tax rates. Some military reservists can borrow or withdraw money from their IRAs without penalty when they are activated for duty. You may also withdraw money from your IRA without additional penalty to pay late taxes to the IRS after they have filed a levy against your possessions.

Penalty-Free Short-Term Loans

Once every 12 months for each IRA account, you can withdraw funds without penalty or tax provided you return those funds within 60 days. This exception is designed to allow rolling over an IRA, but you can take advantage of it for other uses as well. Funds must be returned to the same or a different IRA account within 60 days, or you will incur the regular tax penalty for early withdrawal. Because the penalty for failing to meet the 60-day deadline can be severe, make certain you have the funding to pay back the money you are borrowing from yourself.

Special Situation Exceptions

A few other exceptions are permitted by the IRS. You are allowed a one-time withdrawal of up to $10,000 to pay the down payment on a house if you are a first-time home buyer, or have not owned a principle home for at least two years. For a Roth IRA, you must have owned the IRA account for a minimum of five years. You may also withdraw money to cover approved education expenses, medical expenses in excess of 7.5 percent of your annual income, and to pay for health insurance if you are out of work for over 12 weeks. Amounts in excess of these sums may be borrowed without penalty over a 60-day term. If you take advantage of any of these exceptions, be certain to file an IRS Form 5329 with your regular income tax papers.

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